Mergers and acquisitions (M&A) have become a popular method of business restructuring in the United States and internationally. A merger occurs when two different companies combine together to form a new joint venture company. An acquisition refers to the acquisition of a specific entity by another. Mergers and acquisitions can be doing to improve a business’s reach or increase company profitability in an effort to increase shareholder value. M&A activity are often used to acquire smaller, less profitable companies in order to increase the size of dominant companies.
Acquisitions typically result in cash outlay requirements and long-term commitment to the acquired company’s operations. In some cases, however, mergers and acquisitions provide short-term, cash-rich returns that can lead to substantial profit improvements. Because of the potential long-term implications of acquisitions, however, they are not appropriate for all circumstances. In addition, a successful acquisition requires an understanding of the risks and rewards inherent in the deal. M&A advisers should therefore be careful to ensure that their clients are capable of complying with the expectations of the transaction as well as the laws that may govern it.
Acquisitions involve significant financial risk. The purchasing power of acquired companies may not increase sufficiently to justify the additional investment required. The price per share (PSP) of the target company will usually increase more slowly than the market price if there is significant consolidation or buyout activity. Moreover, acquisitions are sometimes used to extract valuable control shares from existing competitors.
Another major advantage of mergers and acquisitions is the opportunity to use successful business practices as an exit strategy. Typically, existing management structures allow executives to take stock options during or after a sale. Similarly, they can exercise options to purchase minority interests in the target company. Both of these strategies, when used as early exits, can reduce the potential tax impact on the company and its owners. Additionally, the income tax ramifications of a merger or acquisition can be mitigated through the use of corporate shield policies and financing options.
Because of the complex legal and financial issues associated with mergers and acquisitions, seasoned professionals with significant experience in these matters are necessary to assist clients in the negotiation’s documentation. Furthermore, experienced counsel should also be available to manage the portfolio of investments that result from the acquisition. In some instances, limited liability may provide a lower cost structure than equity. In addition, M&A advisers should be familiar with state and local requirements and laws, as well as federal and local restrictions. Finally, during the process of negotiating the acquisition, clients should expect to have to meet ongoing fees due from existing investors, including accrued interest and transfer fees.
One of the primary reasons for a deal structure involving M&A is that it provides a shortcut to achieve multiple synergies. Therefore, mergers and acquisitions are an attractive option for companies that facing growth challenges because of the potential to generate cash quickly. However, the process of acquiring control or owning a large portion of another company requires significant investor approval and a lengthy process.
Unlike traditional mergers and acquisitions, where one company purchases another, a M&A is actually a combination of two private companies. Additionally, unlike stock sales, which occur immediately, M&A is completed over a period of time. During the transaction process, the buyer typically offers either its ownership or substantial equity interest in the acquired company. In most cases, both entities hold a 50% or greater interest in each other. As a result, mergers and acquisitions are difficult to accomplish for private companies that do not control the company’s board of directors or are publicly held companies.
The complexity of mergers and acquisitions makes it necessary for businesses to hire investment banking and financial firms to help facilitate the transactions. Historically, banks have had some success facilitating M&A deals because of their expertise in complex financial transactions and understand the motivation for the buyers and sellers. The financial firms also represent both the seller and the buyer and can facilitate a successful transaction if they are experienced and skilled negotiators. The size and liquidity of a business’s existing customer base is also important. In the case of privately held companies, these elements will vary depending on the size and profitability of the organization. However, by utilizing an investment bank or financial firm to facilitate mergers and acquisitions, businesses can reduce the risk and associated costs and improve their overall profit margin.
